What Is a 2/1 Rate Buydown and How Does It Work?

A rate buydown temporarily reduces a mortgage’s interest rate, allowing for lower monthly payments initially. The 2/1 rate buydown is a specific temporary arrangement designed to ease the financial burden during the early years of a home loan. It provides reduced mortgage payments before the interest rate adjusts to its permanent level.

How a 2/1 Rate Buydown Works

A 2/1 rate buydown progressively increases the interest rate over the first two years. In the first year, the interest rate is two percentage points below the permanent rate. For example, if the permanent mortgage rate is 7%, the borrower pays 5% for the first 12 months.

In the second year, the interest rate increases to one percentage point below the permanent rate, or 6% for months 13 through 24. After this two-year period, the interest rate reverts to the full, permanent rate (7% in this scenario) for the remainder of the loan term. The loan’s principal balance remains unchanged; only the interest component of the monthly payment is affected.

Funding the 2/1 Rate Buydown

The cost of a 2/1 rate buydown, representing the difference between reduced and full payments, is typically paid upfront. This payment is most often covered by a third party, such as the home seller or a builder. These funds are deposited into an escrow account at loan closing.

Each month, the lender draws from this escrow account to cover the difference between the borrower’s reduced payment and the full payment at the permanent rate. If the loan is refinanced or paid off early before the buydown period expires, any remaining funds are typically returned to the party who provided the initial funding.

Implications for Borrowers

A 2/1 rate buydown offers borrowers lower initial monthly mortgage payments, providing financial flexibility during early homeownership. This temporary reduction helps new homeowners adjust to expenses like moving costs or home improvements. It can also benefit those who anticipate an income increase within two years, making the eventual payment rise more manageable.

Borrowers must assess their ability to afford mortgage payments once the interest rate adjusts to its permanent, higher level after two years. The permanent payment should be sustainable within their budget, rather than relying solely on the initial reduced payments. While refinancing the loan before the buydown period ends is a possibility to secure a lower long-term rate, this option is not guaranteed and depends on market conditions and the borrower’s financial standing.